You would like to be holding a protective put position on the stock of XYZ Co. t

Question

You would like to be holding a protective put position on the stock of XYZ Co. to lock in a guaranteed minimum value of 190 at year-end. XYZ currently sells for 190. Over the next year, the stock price will either increase by 8% or decrease by 8%. The T-bill rate is 3%. Unfortunately, no put options are traded on XYZ Co. a. How much would it cost to purchase if the desired put option were traded? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Cost to purchase $ b. What would be the cost of the protective put portfolio? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Cost of the protective put portfolio $

Explanation / Answer

a. Given that Stock price today = $190

and the price of after 10% increase and 10% decrease = $209 and $171 Respectively.

Here we have Option value = $190 x (1+10%) - $190 = $19 , if price increases by 10%

and Option value = $190 x (1-10%) - $190 = $0 , if price dereases by 10%

Now we have

Therefore Price of the option = Spot price x D + B = $190 x (-0.5) +$99.5238 = $4.5238 or $4.52

b.

The cost of the protective put portfolio is the cost of one share plus the cost of one put:

$190 + $4.5238 = $194.5238 or $194.52

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